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Will Congress Take Away Your IRA?

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For decades, tax-favored retirement accounts have given savers their best chance to gather up a big enough nest egg to have a prosperous, financially secure retirement. But as the federal government looks for ways to increase tax revenue, some have feared that the tax breaks that IRAs and 401(k) plans enjoy might be on the endangered list -- and a recent move in Congress brought those fears to the forefront.

On the chopping block?
A recent amendment to a minor piece of legislation set off alarm bells within the retirement savings community. The proposed amendment would have changed the rules governing IRAs to force those who inherit them to cash them out more quickly than current law requires. In the end, the proposal never became part of the final law.

But as the recently proposed federal budget shows, the government is hungry for tax revenue, and one potential source comes from retirement accounts. Although some fears are overblown, others are much more likely to become reality -- and you may want to start planning for them sooner rather than later.

The deal of the century
Perhaps the biggest criticism of retirement accounts from an income-tax standpoint is that under current law, there's a huge incentive for people not to use them for retirement. Consider the following:

  • With traditional IRAs and 401(k)s, you're not required to start taking withdrawals until you turn 70 1/2. Even then, you only have to withdraw about 6% of your retirement nest egg.
  • For Roth IRAs, there's no requirement to make withdrawals at all.

When you combine this with extremely generous laws that allow people inheriting IRAs to stretch out withdrawals over their entire lifetimes, you have the potential for a multigenerational tax windfall that arguably goes well beyond what anyone would have intended for a retirement account.

It's entirely possible that these inheritance laws could be changed to reflect the primary purpose of IRAs and 401(k)s as covering retirement expenses. Forcing accelerated withdrawals would pump more tax revenue into the federal system more quickly, producing the budget savings that Congress is searching for.

That would be good for Uncle Sam but bad for a range of businesses. Some of them would include:

  • Financial companies Bank of America (NYSE: BAC  ) and Wells Fargo (NYSE: WFC  ) have identified retirement plans as an area with huge growth potential, as they beefed up their retirement-plan staffing to try to compete. Similarly, discount brokers E*TRADE Financial (Nasdaq: ETFC  ) and TD AMERITRADE (Nasdaq: AMTD  ) value rollovers from retirement plans enough to pay generous rewards for them. Without the multigenerational "stickiness" that current tax law encourages for retirement accounts, their efforts to hold on to assets indefinitely won't be as successful.
  • Similarly, trust company Northern Trust (Nasdaq: NTRS  ) benefits from managing assets for longer periods of time. It could suffer from greater retirement-plan asset turnover.

Still, it's hard to argue that such changes would be against the spirit of the original provisions of the law.

Don't worry too much
As often happens, though, some fear even bigger changes. A few sources have mentioned the possibility of taxing currently tax-free Roth IRAs, while others have even raised false conspiracy theories about IRAs being confiscated. Such major retroactive changes, while theoretically possible, would be politically difficult to apply against those who took the initial provisions into consideration in deciding to open accounts in the first place.

Whatever happens, we're entering a volatile time for the legal and tax environment. As key tax cuts approach expiration and budget pressures increase, it'll become increasingly difficult to plan your finances for every contingency. Only by staying abreast of the latest developments can you hope to navigate the maze of tax and other laws safely.

Retirement plans are just one key element of a successful financial plan. You also need the best investments you can find. To get some smart long-term investment ideas, check out The Motley Fool's latest special report. We highlight three smart stock picks for retirement investors, and we won't charge you anything at all for it -- but it won't be around forever, so read it today while it's still available.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

Fool contributor Dan Caplinger thinks of his late mother every year when he gets a few hundred bucks from his inherited IRA distribution. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Wells Fargo and Bank of America and has created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of TD AMERITRADE. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't take your sunshine away.


Read/Post Comments (26) | Recommend This Article (42)

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  • Report this Comment On February 15, 2012, at 10:54 AM, wolfman225 wrote:

    <<"... while others have even raised false conspiracy theories about IRAs being confiscated.">>

    Are you absolutely sure it's such a false theory? Just a few years back an idea was floated to mandate that employers require that a portion of employees' contribution into 401k plans be put into "safe" investments such as T-bills and government bonds in order to "protect workers and unsophisticated investors from the vagaries of the market".

    The government would then be free to use this "new" revenue for immediate spending purposes while giving the plan participants instruments only marginally more secure than the IOU's that currently fill the SS "lock box".

    When you add to that the more recent proposal that government (through employers) make participation in company-sponsored retirement plans mandatory unless the employee specifically opts-out, it strikes me that the idea may not be as far fetched as some would have me think.

    While it's quite true that wholesale confiscation of private retirement accounts would create such an outcry as to make it politically difficult, we only need to look back at the machinations involved in the passage of ObamaCare to see just how little public opinion matters when it comes to something that government really wants to do.

  • Report this Comment On February 15, 2012, at 11:04 AM, Timkatt wrote:

    It would be helpful if the author would post the details of this "...minor piece of legislation.." like the name of it or the bill number. Some of us like to read the actual legislation.

  • Report this Comment On February 15, 2012, at 11:50 AM, TMFGalagan wrote:

    @Timkatt - You'll find the proposal on pages 16 to 19 of the PDF found at this link:

    http://image.emarketerpro.skylinetechnologies.com/lib/fe5f15...

    best,

    dan (TMF Galagan)

  • Report this Comment On February 15, 2012, at 11:56 AM, TMFGalagan wrote:

    @wolfman225 -

    Wholesale confiscation of retirement accounts would violate the takings clause of the Constitution. It's not even worth talking about. Teresa Ghilarducci's proposal for replacing or supplementing 401(k)s wouldn't have had any impact on existing accounts, yet many media outlets jumped to the ridiculous conclusion that it amounted to confiscation.

    The sad fact of the matter is that the only way many people ever participate in 401(k)s is if their employers have automatic enrollment. If more people took an active role in saving for their retirement, the issue would be largely moot.

  • Report this Comment On February 15, 2012, at 12:32 PM, Mega wrote:

    My theory is the paranoia around IRA confiscation is caused by widespread toxoplasmosis.

  • Report this Comment On February 15, 2012, at 1:01 PM, jdmeck wrote:

    I have no problem with changing the rules to force withdraws. The money was put there for retirement and that's what it should be used for. It's better than an overall tax increase.

  • Report this Comment On February 15, 2012, at 2:07 PM, mountain8 wrote:

    retirements last longer now-a-days. You tell me when I'm going to die and I'll tell you how much and how fast I'll withdraw it.

  • Report this Comment On February 15, 2012, at 2:53 PM, DJDynamicNC wrote:

    "When you add to that the more recent proposal that government (through employers) make participation in company-sponsored retirement plans mandatory unless the employee specifically opts-out, it strikes me that the idea may not be as far fetched as some would have me think."

    I don't think a situation where employees can opt-out counts as mandatory.

    As Dan points out, opt-in 401(k) accounts have been a complete failure at replacing pensions for retirement purposes. People simply don't do it. While a defined benefit plan makes for a much higher standard of living and quality of life for American citizens, at least default-in 401(k) accounts have proven to be much more effective at getting people to save.

    It's easy to stand there and moralize over "well people should save for retirement." Because you're right, of course. But it is equally important to be effective. People are people. They're going to screw up, they're going to plan badly, they're going to make bad choices (we've all done it and you know it - I've made more than my share of stupid calls). Accounting for that and building a system that has some accommodation for that human tendency is smart, sane, and compassionate. All things I aspire for, as a person and as a citizen.

  • Report this Comment On February 15, 2012, at 3:01 PM, deckdawg wrote:

    Dan, I fail to see how the article linked to by "false conspiracy theories" illustrates the fact that the conspiracy theories are false. Instead, it described someone proposing that the government force holders of existing 401K accounts to place their savings into (presumably) government bonds. While there may not be a "conspiracy", those enamored of big government are constantly looking for more money, and you can bet they are drooling over the trillions of dollars currently sitting in retirement savings. They will find ways to get their hands on some of it, at least. In fact, once you have piled up a little money, you will always attract the interest of a large assortment of politicians and other con men. "Why do you rob banks?" "Because that's where the money is" answered Willie Sutton.

  • Report this Comment On February 15, 2012, at 4:05 PM, wolfman225 wrote:

    --@DJ,

    "As Dan points out, opt-in 401(k) accounts have been a complete failure at replacing pensions for retirement purposes. People simply don't do it."

    And that makes their financial security my responsibility? How, exactly? The fact that (some) people will fail to plan responsibly for their retirement years and, instead, pursue a "life full of experiences" by spending their money as soon as it is acquired doesn't obligate me in the slightest. Neither do I feel sorry for those spendthrifts who borrowed and spent themselves into a crisis.

    The fact that I (hopefully) have managed to acquire some measure of financial security by living according to the tenets of LBYM and deferred satisfation entitle others to a share of what I have.

    Pensions, also have proven to be notoriously unreliable. You don't have to look too long or hard to find examples of (deliberately) under-funded pensions being wiped out, both at the corporate and government level.

    As you say, people will screw up. That most definitely includes those who presume to save us from ourselves. I am not so sanguine as Dan about the impossibility of a future government takeover of private retirement plans. It needn't be all at once. In fact, I would expect it to be a gradual process over a period of maybe 10 or even 15 years. The idea that it won't happen because it violates the Constitution is laughable. How many government actions have we seen over just the last 20-30yrs that are either borderline or extra-constitutional?

    Despite protests (from both parties) that the actions of the other are unconstitutional "power grabs" you'll notice that the one thing guaranteed not to happen in a change of the party in power is a reduction in the reach and authority of government in our personal lives.

    More and greater government power is never the panacea it is promoted to be. Instead, it's a halter with only one purpose: to control the population.

  • Report this Comment On February 15, 2012, at 5:30 PM, stmmmd99 wrote:

    mountain8, it will be on a Tuesday. Mostly likely when you're on the can. That's how I plan to go!

  • Report this Comment On February 15, 2012, at 6:10 PM, DJDynamicNC wrote:

    @Wolfman - You raise fair concerns, and believe me, I'm well aware that government-based solutions can and will go wrong. It's a standard cost-benefit analysis. For example, prior to Social Security, we had senior citizens starving and living in misery. Social Security has alleviated a LOT of that, despite some inefficiencies and missteps. Worth the cost, in my opinion.

    It's easy to cast it as a moral high ground when you characterize the recipients of Social Security as spendthrift grasshoppers who simply didn't do their part. Just as easily, however, they could be people who spent their lives in a career with a defined benefit pension that has now been eliminated. Or people who trained in skills that have been made obsolete by technology - entering a new industry would mean a massive pay cut for such a person. Or people who made a bad choice while young and never recovered. Or people who work minimum wage jobs their whole life and simply never get far enough ahead to save for retirement.

    I would argue that EITHER WAY, however, we have a responsibility to one another to look out for each other and to provide for a bare minimum for the people as a whole. This makes economic sense and it makes ethical sense. I am my brother's keeper.

    I don't envision needing any safety net programs - I was poor for so long that now that I'm not, I'm saving furiously to ensure I never am again - but it's always a possibility that I may. But even if I never touch a government dime, I recognize that I benefit from living in a nation with less poverty, with fewer people turning to crime to make a living, with more people spending more money, with more people happy and content and able to meet their basic needs. And not only do I benefit from that, I am proud to support it on ethical terms too.

    I believe that America is more than efficiency.

  • Report this Comment On February 15, 2012, at 9:00 PM, kabrink wrote:

    Please show my how to get all of my money out of this damn country before they figure a way to take it all. How about the govt learn to slim itself down first and live within a budget before it asks for more and more money. Gee, how revolutionary.

    @mountain8: Don't worry, that's what obamacare is all about. They'll let you know.

  • Report this Comment On February 16, 2012, at 7:39 AM, dianevin wrote:

    If the government needs to increase tax revenues, I suggest they leave our retirement accounts alone and instead apply the federal gift tax to all political donations - that would seem to be more of a revenue raiser, especially this year.

  • Report this Comment On February 16, 2012, at 10:41 AM, DJDynamicNC wrote:

    @Kabrink: "Don't worry, that's what obamacare is all about. They'll let you know."

    My goodness, that sounds terrifying. Can you point out where exactly in the law it gives doctors the ability to dictate your time of death?

  • Report this Comment On February 16, 2012, at 1:43 PM, Okiehound wrote:

    You call it conspiracy & false concern, I call it predicting future behavior by observing past actions. We have a president who does not mind walking on the constitution when it suits his needs. Ask the former bond holders of GM and Chrysler if there is reason to be concerned. Ask the "occupiers" if 401K accounts of the rich should be confiscated. I have completely lost faith in our government. Concern over breaking previous promises or something being unconstitutional give way to political expediency. We are heading for where Greece is at and have a president determined to get us there ASAP. Want to save your 401K? Start protecting it in the voting booth. But it could be too late already.

  • Report this Comment On February 17, 2012, at 10:44 AM, DJDynamicNC wrote:

    I'm an Occupier, I've never heard anybody propose that we take the 401(k) accounts of the rich. We're looking to close the carried interest loophole, end the Bush tax cuts, and restore fiscal sanity and ethical government to the fore.

    I find it telling that the bond holders of GM are more important to you than the job holders. I also wonder just how happy those bond holders would have been with a constrained liquidation of the company's assets. If you really think that would have been a better outcome for the nation and for bond holders, I'd be interested in hearing your reasoning.

    Next time you say "ask an Occupier," you may wish to actually do so first.

  • Report this Comment On February 17, 2012, at 1:12 PM, WineHouse wrote:

    I recently took advantage of the new law that allows anyone with a traditional IRA to roll part or all of it over to a Roth IRA. All you need to do is pay the income tax on the not-yet-taxed part, and voila -- you have tax-free income accreting in that account for not only the rest of your life, but also the rest of your lineal descendants' lives. Not bad! In fact, it's a cynical work-around that gets around the rule that says that you can't contribute to a Roth unless your income is in the lower half nation-wide. That rule was put in place because the original intent of the Roth IRA was to help the lower middle class provide for themselves during their retirement, and they obviously needed the help a heckuva lot more than the wealthy. But now, even the very wealthy can avail themselves of this give-away.

    Let me illustrate:: imagine that you're very rich, and you are looking for tax shelters for yourself and your heirs. So, you put the maximum into your traditional IRA every year. Because your income is above the "deductible" limit, you pay the income tax on the money you put in, so it's "basis" (the tax is already paid on that sum). The next year, you roll last year's contribution over into a Roth, and put this year's contribution into the traditional. Assuming a modest 6% growth over the course of the year, you pay additional income tax on that 6% incremental accretion. The next year, you do the same. BUT -- the money in the Roth is accreting at the same 6%, and it's NOT taxed. Year after year, more and more money piles into the Roth, some of it "new" but most of it from prior years and accreting. Let's say you start when you are 27 years old. And let's assume that you are in the top 1% of earners, so yu are able to accumulate plenty of savings inaddition to and outside of your tax-deferred accounts (and that you invest that money wisely). At age 60, you "retire" so you are no longer eligible to add money to a traditional IRA. But you've accumulated plenty of additional tax- deferred money in your 401K or your SEP or your BASIC or your "Defined Benefit Plan." Now you can roll all of that over into a traditional IRA, and then you can roll as much as you want, whenever you want, from that traditional IRA to your Roth so long as you are willing and able to pay the income tax on the rolled-over sum out of "other" (non tax-deferred) accounts. Whatever you have in the Roth need never be drawn down by you, never incurs income taxes whether you withdraw funds or not, and can be inherited by your kids or grandkids under exactly the same forever-tax-exempt status. Isn't that lovely? Do the math. It's mindboggling, how much future tax will be avoided by the wealthy from now on.

    Like I said, I've taken advantage of it. I did it in 2010, two years after I retired, as soon as the law allowed me to. I figure the tax I paid on (traditional IRA plus 401K) rollover will be more than made up for within eight or ten years, and after that it's pure gravy.

    But I'm a decent sort, and the fact is that I feel guilty about this, even though in my case it's relatively small potatoes (I've been a salaried mid-level manager during my entire working career, so I'm comfortable but not a "big fat cat"). I would prefer to see this unlimited rollover provision repealed, because I think in the long run this provision will be a major drain on the US economy as well as the Treasury, and just one more (albeit probably the BIGGEST) undeserved tax windfall for those who need it the least.

  • Report this Comment On February 17, 2012, at 3:32 PM, golfer121501 wrote:

    "Forcing accelerated withdrawals would pump more tax revenue into the federal system more quickly, producing the budget savings that Congress is searching for."

    WHAT??!!! How does more tax revenue equal "budget savings". More revenue is more revenue, budget savings is spending LESS money, something this administration has NO clue how to do in any way.

  • Report this Comment On February 17, 2012, at 3:38 PM, PonderingItAll wrote:

    WineHouse: I've seen some models of the taxes you end up paying now for a Roth Conversion, versus paying the taxes on an unconverted standard IRA as you withdraw the required amounts each year. When you factor in the future value of money, etc. it looks about like a wash.

    Of course, that assumes tax rates will remain the same, account earnings remain the same, and that congress doesn't change the rules! I assume income tax rates will rise, so I collected all of my 401K rollovers, regular IRAs, SEP IRA, etc. into a ROTH conversion back in 2010 just like you did.

  • Report this Comment On February 19, 2012, at 12:11 PM, sthtxs wrote:

    Anyone who thinks the Constitution protects them from anything is living in fantasy land. Look at the dozens of things Congress does that are not Constitutional.

    I would not put it past the greedy government to steal 401k's and IRA's.

    I never feel guilty being able to keep more of my money. I'm for abolishing the federal income tax since the Federal government has become little more than a criminal enterprise. Its the same with many state and local governments, but its easier to drive to your state capital rather than DC.

    Don't forget it has already been done in Argentina and Ireland. I'm sure some crisis will be manufactured to justify stealing whatever they can get. Look at the MF Global scandal; since Corzine is a buddy of Obama, I find it doubtful he will be prosecuted. Not that it would be different under tyranny with an 'R'.

    Think people!!!!

  • Report this Comment On February 21, 2012, at 10:22 AM, DJDynamicNC wrote:

    "Look at the dozens of things Congress does that are not Constitutional. "

    I'd be interested in some specific examples.

    I'd also be interested in discovering why these unconstitutional acts are not being pursued in Supreme Court cases.

  • Report this Comment On February 21, 2012, at 5:22 PM, aleax wrote:

    Hi DJDynamicNC,

    """

    "Look at the dozens of things Congress does that are not Constitutional. "

    I'd be interested in some specific examples.

    """

    Levin and McCain's S. 1867, AKA "National Defense Authorization Act", recently passed by a large bipartisan majority and signed by the President despite some grumbling, is probably the single most blatant example -- blatantly violating about half the Bill of Rights, it seems to me (and to a lot of other lovers of liberty who usually disagree on most issues, from the ACLU to Ron Paul).

    """

    I'd also be interested in discovering why these unconstitutional acts are not being pursued in Supreme Court cases.

    """

    Who do you think currently has standing to sue about the NDAA? I believe that, to get standing to sue, you need to prove you've been directly and personally damaged, and you usually have to go through lower Federal courts first anyway.

    Many years from now, once somebody's spent years without a trial in illegal military detention, a suit MIGHT eventually be allowed (if the Supremes feel like it at the time).

    Other Congress provisions which their opponents believe DO breach the Constitution, like the mandate for individual health insurance, ARE already "being pursued" -- after contradictory sentences by different federal circuits, probably the most direct route to convincing the SCOTUS to hear your case (some of those sentences just denied standing to parties who could not prove they were directly damaged, but there's enough contradiction between those and others that nobody was surprised when a notoriously conservative leaning court granted certiorary in the case;-).

  • Report this Comment On February 22, 2012, at 10:56 AM, DJDynamicNC wrote:

    Aleax - that's a good example! I would be willing to accept that as solid evidence that Congress does engage in unconstitutional behaviour. I will concede the point.

    The mandate for individual health insurance unequivocally is NOT unconstitutional - see the Militia Act of 1792 for the nation's first example of an individual mandate for private citizens to make a consumer purchase in the pursuit of a national interest, as ordered by one Mr. George Washington, in whom I have the utmost confidence for understanding what the Founders intended with the Constitution.

  • Report this Comment On February 22, 2012, at 12:30 PM, Bmayo27 wrote:

    Dear DJDynamicNC - Thank you so much for your intelligent responses! I'm not being sarcastic.

    I loved your response about mandatory Retirement contributions, "Accounting for that (people will screw up) and building a system that has some accommodation for that human tendency is smart, sane, and compassionate. All things I aspire for, as a person and as a citizen." I couldn't have said it better.

    I highly recommend "The Millionaire Next Door" audio CD (it's only 2 CD's). Just trust me, you'll enjoy it greatly!

    Thanks for sticking up for the more humane act, of trying to help people! Cheers and God bless!

  • Report this Comment On February 22, 2012, at 2:30 PM, DJDynamicNC wrote:

    Bmayo, thanks for the kind words. :)

    I got a Kindle for Christmas and I'm eager to fill it, so thanks for the recommendation, I'll pick that up.

    Fool on!

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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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